Turning on the power at BE

NUCLEAR energy has been dangerous ground for investors. After British Energy was privatised in 1996, its shares soared into the top 100. At their peak 750p, the market value topped £5bn. Then the wheels came off and they sank to 3.2p.

Today they are 5.1p and that is largely hope value. For a year BE has teetered close to collapse after electricity prices plunged when the market was liberalised. It lost £4.3bn last year (mostly in write-downs) and had to crawl to Trade Secretary Patricia Hewitt for a £650m loan guarantee to keep it alive.

The price was severe. BE had to sell its profitable North American power stations. It entered long drawn out talks with its creditors. Inevitably, it also has a pension deficit. Receivership is a real risk if the rescue breaks down. Last month, two power stations shut down temporarily for safety reasons. One is still out.

The rescue awaits clearance from Brussels next July or August. Then creditors get most of the enlarged equity. Present shareholders keep just 2.5%, with the right to a further 5% in five years at a cost of £29m.

After this catalogue of woe, why go anywhere near BE? Because Britain's looming energy shortage is changing the picture.

In simple terms, BE lost money because it was generating power at £21 per megawatt hour and selling at £18. The price for forward sales has now bounced to £23. Sadly the rescue forced BE to sell forward at just £18, so it does not benefit until 2004/5.

New chief executive Mike Alexander, formerly at Centrica, aims to cut costs to £14.50, which could transform the economics. He has hired consultants to find out why BE's plants run at 77% of capacity, when US rivals manage 95%.

If EU clearance arrives and power prices stay up, the upside could be startling.

BE supplies one-fifth of Britain's power, worth £1.5bn last year. Higher prices make a huge difference. In 1999, operating cash flow was £479m - at lower power prices than now.

The question is how much the rescue has damaged investors. BE is largely working for its creditors.

The Government gets 65% of cash flow after the rescue. That leaves 35% for shareholders. Present investors get just 2.5% of that.

But if BE could return to its old profit margins, present investors' share of cash flow could be close to £5m a year. That alone is worth the present share price.

Once investors take up their options on 7.5%, their share of cash would treble. BE could also make money from trading its emission rights.

The risks are high. Shareholders are at the mercy of bondholders and politicians - an unenviable combination.

The nuclear industry can turn a sunny day into a firestorm. But for the brave, there is upside.

Water firms set to turn on income tap

UTILITIES are back into favour, helped by National Grid's dividend hike. That reminds us of the income attractions of water companies, which should grow as rising investment costs bring an easing of price curbs.

The market is sceptical. United Utilities has fallen £1 since June. But watchdog Ofwat has cleared price rises of 3.7% from April. For the next five-year review, UU sought 12% a year.

It will seek less now, but bills are likely to rise sharply. Hard for customers, but this adds £40m to UU's revenues and underpins its dividend yield, already the highest in the top 100.

Adjusting for UU's rights issue, the payout this year should be 43.2p. At 493p that gives a yield of 8.8%, narrowly covered by net profits.

Tax free in a PEP or ISA, that still looks attractive, though not as attractive as the A shares at 295p.

You get half the dividend, for a 7.3% yield and face a cash call of 165p a share in 2005. If the price review goes favourably, they will rise more sharply than the old shares.